Treasuries sold off on Friday after hawkish remarks by a Federal Reserve policy maker drove the 10-year yield above a key support level, signalling that a bearish move that began this week will continue. Charles Plosser, the president of the Federal Reserve Bank of Philadelphia, told an audience in New York that the Fed would have to raise rates and shrink its balance sheet "in the not-too-distant future" in order to avoid damaging the economy through inflation.
Following the remarks, the 10-year yield hit 3.43 percent, an important support level, and the price on the 10-year - which moves inversely to the yield - triggered stop-loss trades at 101.24. "This is bad news for bondholders because if the Fed's got to sell anything off their balance sheet, yields are going to go through the roof," said Todd Colvin, vice president at MF Global Securities in Chicago. "And that is why the market has the case of the yips here."
"What does this do for long-term lending?" Colvin said. "A lot of negatives here, but Mr Plosser believes that's what's needed in order to avoid inflation." Colvin said the sell-off was muted by traders' understanding that Plosser is a renowned hawk on the US central bank's policy-setting Federal Open Market Committee, and not all voting members share his views.
"This is one man's opinion right now and it's certainly not what we can expect at the next FOMC meeting to be discussed in a serious manner," Colvin said. Ten-year notes were last trading 12/32 lower in price and yielding 3.45 percent, up from 3.38 percent late on Thursday. It was an indication that the sell-off, small though it was, could be the beginning of a move to higher yields. Rick Klingman, managing director of Treasury trading at BNP Paribas in New York, said traders had begun to look to 3.47 percent and then 3.50 percent for more support points. Marty Mitchell, chief market technician at Stifel Nicolaus in Baltimore, said the next important point for 10-year yields was 3.60 percent.
One sign that yields may continue to rise is that real yields this week became less negative for first time after a five-week rally sent them to the most negative levels in at least five years. "It definitely could be the start of yields moving higher and taking back some of that flight to quality," said Igor Cashyn, interest rate strategist at Morgan Stanley in New York. Real yields measure Treasury returns when adjusted for expected inflation, and negative real yields suggest that Treasury yields will need to rise more to account for inflation, if current expectations prove correct.
Upcoming auctions also drove some of Friday's selling, since traders will not have the customary time to prepare their positions on Monday. The Treasury will sell $99 billion in two-year, five-year and seven-year notes next week, the first Treasury supply in three weeks, and the auctions will begin Monday instead of Tuesday, since their settlement dates are all March 31.
Two-year notes were off 4/32 in price to yield 0.76 percent, up from 0.71 percent on Thursday. Five-year notes lost 8/32 in price to yield 2.17 percent, up from 2.12 percent late on Thursday. Seven-year notes rose 9/32 to yield 2.85 percent, up from 2.80 percent. Thirty-year bonds fell 13/32 in price to yield 4.51 percent, up from 4.48 percent late on Thursday. The gap between yields on five-year notes and 30-year bonds, meanwhile, compressed to 236 basis points, the lowest level in around three weeks. The gap has strong resistance at around 230 basis points, analysts said.